NZ financial system sound, still faces risks

May 31 (BusinessDesk) - New Zealand's
financial system is sound but housing market vulnerabilities
remain a key risk and the central bank still wants to curb
high debt-to-income lending if necessary, it said in its
twice-yearly financial stability report.

Since the last
report, house price inflation has moderated and banks are
more resilient to a market downturn, but houses remain
overvalued in many parts of the country and some homeowners
are vulnerable to a potential fall in incomes or a rise in
mortgage rates, it said. "A further resurgence in house
prices would be of real concern, given existing
affordability constraint," it said.

New Zealand's housing
market has been running hot, spurred by record high
immigration and record low interest rates. Over the past
several years, the central bank has introduced
loan-to-valuation ratios on borrowing for housing in a bid
to curb lending. The central bank said the LVRs have had an
impact, with annual national house price inflation, as
measured by the Real Estate Institute’s house price index,
at 8 percent in April from around 14 percent in October.
However, while they have helped insulate the banking system
from a housing downturn, low mortgage interest rates have
encouraged an increase in high debt-to-income lending.

"Borrowers with high DTI ratios are typically more
exposed to a rise in interest rates or a decline in income,"
it said. Earlier this year, Finance Minister Steven Joyce
called for a full cost-benefit analysis on proposed
debt-to-income home lending limits and said public
consultation will be conducted by the Reserve Bank before
any decision is made on the potential use of the additional
macro-prudential policy tool.

In today's financial
stability report, the central bank said it will shortly
release a consultation paper proposing that DTI ratio
restrictions be added to the Reserve Bank’s
macroprudential toolkit.

It said, however, if a DTI tool
was available, the Reserve Bank would not apply it at this
stage, given that LVR restrictions appear to be mitigating
housing risks. However, "should high house price growth
return and the proportion of housing lending at high DTI
ratios remains high, a DTI restriction could be
warranted."

The central bank also signaled bank funding
pressures and dairy sector indebtedness as other key risks.
While these risks have also moderated it said New Zealand
banks have become more reliant on offshore funding to
support new lending, exposing them to international risks
that could disrupt global markets.

It said that global
political and policy uncertainty "remains elevated" and debt
burdens are high in a number of countries. "A sharp reversal
in risk sentiment could lead to higher funding costs for New
Zealand banks and an increase in domestic borrowing costs.
Rising protectionism could also affect the trade-exposed
sectors of the New Zealand economy," it said.

It
reiterated it is currently undertaking a review of bank
capital requirements and recently released an issues paper
detailing the intended approach and scope of the review. It
said principles underpinning the review include that capital
requirements for New Zealand banks should remain
conservative relative to international peers and that
complexity in capital regulation should be reduced where
possible.

Regarding dairy it said that after two years of
low prices, whole milk powder prices increased by 45 percent
over the past 12 months and the majority of dairy farms are
now expected to be profitable in the current season.
However, "indebtedness in the sector has continued to
increase, and the most indebted dairy farms remain highly
vulnerable to lower dairy prices or an increase in costs,"
it said.

Banks should continue to closely monitor and
maintain full provisioning against lending to high-risk
farms, it said.

The Wellington-based BusinessDesk team led by former Bloomberg Asian top editor Jonathan Underhill and Qantas Award-winning journalist and commentator Pattrick Smellie provides a daily news feed for a serious business audience.

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